What are we looking for?
Part of Warren Buffett's investing strategy is to find companies that have a wide economic moat. These are companies that have a sustainable advantage in the marketplace that protects them from competitive forces. Today, we'll look for Canadian stocks that might qualify as moat stocks, according to Mr. Buffett.
More about today's screen
Morningstar has an comprehensive system of identifying companies that have moats. The system seeks to identify moat companies according to five types of competitive advantages:
-intangible assets: brands, patents and regulatory licences;
-cost advantage: able to produce products or services at a lower price than the competition;
-switching costs: allows companies to charge customers more than they would otherwise be able because switching to a new supplier is too costly;
-network effect: the value of a company's product or services increases as more customers are added;
-efficient scale: effectively serving a limited market, where potential competitors have little incentive to enter the market.
What did we find out?
Morningstar has identified 160 wide-moat companies amongst the companies it follows, with most of them trading in North America. Nine of them are Canadian. The big five banks, Bank of Montreal , Bank of Nova Scotia , Canadian Imperial Bank of Commerce , Royal Bank of Canada and Toronto-Dominion Bank , dominate the list.
Interestingly, Morningstar calculates that the moat category that generates the highest returns on invested capital is the network-effect one. Ritchie Bros Auctioneers Inc. is the lone network-effect company on the Canadian list.
"The network effect is a virtuous cycle that allows strong companies to get even stronger," Morningstar said in a report. "The network effect is probably the most potent source of a sustainable competitive advantage, but it's also one of the rarer categories."